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Interest rates rise

Thursday 9th November 2017

On Thursday 2nd November, the Bank’s Monetary Policy Committee (MPC) voted 7 to 2 in favour of raising the Bank’s benchmark by a quarter of a percentage point to 0.5%, and signalled the start of a gradual increase in borrowing costs.

The intention was to send the ‘hawkish’ message that at least two further increases of a quarter of a percentage point each would be needed over the next two years to control inflation. Governor, Mark Carney’s, main point being that the UK’s economy still needed further tightening of monetary policy. ‘We in fact need those two additional rate increases in order to get that return of inflation to target’ adding that even the rate increases priced in by the financial markets ‘doesn’t quite get there’.

However, the message was a little lost in translation for the financial markets as it was initially interpreted as a ‘dovish’ – that future rate increases would be limited. Sterling fell 1.4% against the dollar to $1.3059, and weakened against the Euro, falling by 1.7% to €1.1202. The MPC had intended the message to be that this was not a ‘one and done’ decision that simply withdrew the additional stimulus provided after the Brexit referendum last year.

This first monetary tightening in a decade comes despite forecasts for relatively weak economic performance. The MPC now expects the UK economy to grow at about 1.7% per year during the next three years, which is well below the 2.5% average seen since WWII. And it now thinks the economy can grow by only 1.5% per year without generating inflation.

As Mark Carney said: ‘with unemployment at a 42 year low, inflation running above target and growth above its now, lower speed limit, the time has come to ease our foot off the accelerator.’ And ‘future increases in the bank rate would be at a gradual pace and to a limited extent’.

This increase is of course the news that savers have long been waiting for. Although the returns are still far short of the levels enjoyed by savers from even just two years ago. Homeowners, however, particularly those on tracker or variable rates, or those with buy-to-let mortgages that tend to be interest only products, will not necessarily be celebrating. That said, around 50% of outstanding mortgage debt is on fixed rate deals so won’t be immediately affected. But lenders have already indicated that they will be passing on the full rate increase to borrowers with immediate effect so those on relatively short fixes of say two years might need to prepare themselves now.

The rate rise is also good for retirees as annuity rates follow the yields (interest rates) on long-dated government bonds (or gilts). With the expectation of rising base rates, these yields have also been rising which means retirees get better value for money when they buy an annuity.

There will always be winners and losers with rate increases but the key point is to make sure you have a robust plan in place to help future-proof your finances.